A Hair Trigger Rally

By the first week of October, after having dropped more than 18 percent from
its highs achieved in May 2011, U.S. stocks were desperate to latch on to any
good news. In this context, the apparent agreement between the major European
players to kick their debt can down the road was viewed as an "all clear" for
shell shocked investors.

Since October 4th the Dow has rallied almost 10 percent, one of the best 10-day
stretches in the history of the stock market. The gains have been enough to
push the Dow into positive territory for the year. However, the agreement in
Europe that sparked the good times solves absolutely nothing and virtually
assures that problems will re-emerge in the near future.

To salvage their most indebted banks and some of their struggling periphery
members, including Portugal, Ireland, Italy, Greece and Spain, Europe has agreed
to create, and fund, the 440 billion euro ($590 billion) European Financial
Stability Facility. It remains to be seen how this extra layer of bureaucracy
will make any difference in putting the continent back on a sustainable path.

While a meeting between two Euro leaders (Sarkozy and Merkel) may have galvanized
Eurozone politicians into more dramatic group action, the new Facility fails
to address the intractable political problem that solvent countries are tiring
of funding profligate neighbors. It also fails to reverse the fundamental structural
problems that plague the euro.

Just a few weeks ago, when the EFSF bailout fund was announced, it was widely
trumpeted as a cure-all. However, many have already deemed the Fund to be too
small, with some calling for it to be increased five times to over $2 trillion.
However, even $2 trillion would be a paltry sum with which to confront any
debt problems erupting from larger countries such as Italy.

In his recent attempts to block the adoption of the EFSF, Mr. Richard Sulik,
leader of Slovakia's Freedom and Solidarity Party said "I'd rather be a pariah
in Brussels than have to feel ashamed before my children who would be deeper
in debt should I raise funding for the EFSF bail-out mechanism." I believe
that the vast majority of EU's 400 million citizens would echo this view. But
with democracy crushed almost to death already within the EU, such a view would
not easily be published. Unfortunately for young Slovaks, the plan passed.

The recent collapse of Dexia Bank, which had been considered to be fiscally
sound earlier this year, was too big for Belgium to handle. Help was required
from France and Luxembourg. However, it is important to understand that there
are many banks in Europe that may have substantially more "troubled" assets
than Dexia, which carried less than $600 billion of total assets on its balance
sheet.

For instance, the three largest French banks which recently passed the euro
stress test (as Dexia had in the past) have total assets of some $6.3 trillion,
or about half of America's GDP! While it is unclear how much of these assets
would fall into the "troubled" or "toxic" categories, it is reasonable to assume,
given the extent to which these banks have loaded up on sovereign debt, that
the percentage is not insignificant. Clearly then it will not take a tremendous
amount of asset downgrades to force a systemic crisis. On this basis, how much
confidence can be inspired by the new framework?

I believe that it is just a matter of time before these possibly catastrophic
debt chasms erupt into full view. When they do, the euro itself may be pulled
apart. In today's interconnected world, a collapse of the world's second largest
currency would create such chaos that soon it would threaten the continued
viability of the fiat U.S. dollar.

Facing these possibilities, as well as the realities of anemic U.S. economic
growth, and the risk of disappointing Q3 corporate earnings, it is hard to
trust the recent U.S. stock rally. This is particularly so as the rising stock
prices have been based on very low volume.

It is time for investors to hope for the best but to plan on the worst. Part
of this plan should involve greater care for portfolio currency selection,
which is examined in greater detail in a report
recently put out by Euro Pacific Capital.

John Browne is the Senior Economic Consultant for Euro Pacific
Capital, Inc. Mr. Brown is a distinguished former member of Britain's Parliament
who served on the Treasury Select Committee, as Chairman of the Conservative
Small Business Committee, and as a close associate of then-Prime Minister Margaret
Thatcher. Among his many notable assignments, John served as a principal advisor
to Mrs. Thatcher's government on issues related to the Soviet Union, and was
the first to convince Thatcher of the growing stature of then Agriculture Minister
Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher famously
pronounced that Gorbachev was a man the West "could do business with." A graduate
of the Royal Military Academy Sandhurst, Britain's version of West Point and
retired British army major, John served as a pilot, parachutist, and communications
specialist in the elite Grenadiers of the Royal Guard.

In addition to careers in British politics and the military,
John has a significant background, spanning some 37 years, in finance and business.
After graduating from the Harvard Business School, John joined the New York
firm of Morgan Stanley & Co as an investment banker. He has also worked
with such firms as Barclays Bank and Citigroup. During his career he has served
on the boards of numerous banks and international corporations, with a special
interest in venture capital. He is a frequent guest on CNBC's Kudlow & Co.
and the former editor of NewsMax Media's Financial Intelligence Report and
Moneynews.com. He holds FINRA series 7 & 63 licenses.